There are an overwhelming lot of options involved with the purchasing of a vehicle, and once you decide what car you want, the next decision is to determine the correct financing for your needs. ‘Residual value’ or ‘Balloon payment’ loans certainly allows you better ‘short term’ affordability enabling you to drive a more expensive car that you otherwise would, but can be a very dangerous option in the long run if not understood completely.
Cons of ‘Residual / Balloon’ payment loans
Residual loans are not for everyone and there are quite a few concerns you should be aware of when taking out a balloon payment car loan:
EXPENSIVE IN THE ‘LONG RUN’
Car buyers are attracted to this way of financing because, it make the purchase more affordable in the short run, thinking they will be better off financially when the loan term expire to settle the lump sum. The fact is that most people will not be better off financially in four to five years, as much as they hope or think they will be. A lot of people end up re-financing the outstanding ‘residual’ lump sum making it a much more expensive way of financing a car.
NO EQUITY IN VEHICLE (CONSTANT PAYMENTS)
Some people opt to sell a vehicle at the end of the loan term when faced with the ‘balloon’ payment instead of refinancing the car, then buy a new car and re-enter a ‘residual’ loan agreement. This way you never really own any equity in a car and will always have a vehicle instalment. When you buy outright, you pay/finance the full purchase price and you won the car eventually and have no more car payments.
INTEREST VS VALUE
Having a balloon payment means that you have an additional debt, the lump sun, which you are NOT paying off, but you ARE paying interest on it over the full loan term. At the end of the loan term, you are only paying the interest on the loan and you will likely owe more on the vehicle that it is worth if the interest rate is unfavourable. In such an instance, you could face great difficulty in selling for the amount you owe or refinancing the loan.
In most cases, a balloon loan is not the right financing option, and simply allows you to incur more debt that you can afford by delaying the costs and in the end paying a lot more interest / fees for this privilege.